The economy today Essay Example | Topics and Well Written Essays - 1250 words

The economy today - Essay Example In a closed economy, if the government raises its budget deficit in the short run, both prices and GDP will rise. In the new equilibrium the real income is unchanged but the nominal is higher. The demand for money, then, increases. This means that with a fixed money supply the interest rate will rise so reducing the investment. Thus, the new equilibrium has lower investment demand and lower national savings. This is known as the crowding-out effect. In the case of a large recessionary gap the crowding out effect is much less important because with the rise of GDP determined by the government the volume of private savings will increase and will finance the deficit. By reducing private investment, the crowding out effect implies that the stock of capital to pass on to the future generation will be smaller and smaller will be the output as well. This is the long-term burden of the debt. If government spending crowds out private investment and reduces the wealth of a country, deficits ar e not eliminated or reduced because of short term stabilization policy that reduces the deficit involving real costs today, in higher taxes and lower government services, in exchange for benefits in the future. Such exchange does not appeal to everyone. However, there is little evidence to back up the idea of government borrowing "crowds out" private borrowing and thus reduces private investment and increases interest rates. ... In the new equilibrium the real income is unchanged but the nominal is higher. The demand for money, then, increases. This means that with a fixed money supply the interest rate will rise so reducing the investment. Thus, the new equilibrium has lower investment demand and lower national savings. This is known as the crowding-out effect. In the case of a large recessionary gap the crowding out effect is much less important because with the rise of GDP determined by the government the volume of private savings will increase and will finance the deficit. By reducing private investment, the crowding out effect implies that the stock of capital to pass on to the future generation will be smaller and smaller will be the output as well. This is the long-term burden of the debt. If government spending crowds out private investment and reduces the wealth of a country, deficits are not eliminated or reduced because of short term stabilization policy that reduces the deficit involving real costs today, in higher taxes and lower government services, in exchange for benefits in the future. Such exchange does not appeal to everyone. However, there is little evidence to back up the idea of government borrowing "crowds out" private borrowing and thus reduces private investment and increases interest rates. This has not been the eff ect in Japan, and cannot be shown to be the effect of deficits in the United States. Private savings and investment are reduced by government expenditures--regardless of whether they are financed by government borrowing or by taxation. Either way the private individual is left with less money, and ultimately with fewer resources. The attempt to replace